Friday, June 27, 2008

A Look At Europe

Until oil remits to lower levels, which it will do, the European and US economies are slated to experience extreme difficulties. Let's look at Europe:Spain: It is being hurt very badly by the end of the housing boom. Construction was estimated to account for about 18% of GDP a few years ago, so a slowdown has a major impact on the economy. Sales of cars have been reported down by as much as 20% this year, for example.

Germany: In part, I think there is a banking problem here. The European lending survey showed banks drawing back, and in Germany in particular industry is tied to bank loans to a greater extent than in the US. The expectation is that Deutsche Bank needs to raise capital, and other banks have been either moving to consolidate or requiring similar measures. Also German inflation is running pretty high - food is over 6%. This is similar to most other states in Europe, and it is intimately related to fuel prices. In general the stronger Euro hasn't helped German businesses compete, so there is probably something of a double whammy as world growth slows, input prices rise, and domestic consumption lags. On the other hand, the German economy has a good ratio of production to services so it should remain stronger as a whole than many other regional economies.

Romania/Eastern Europe: Fast growth regions in eastern Europe are generally experiencing epic inflation but expanding economies. But when private debt growth accounts for over 40% of your economy in times like this, central bankers are right to demand changes ASAP. This cannot continue; it will not continue, and when it stops, a bunch of this debt is going to go bad at once. Romania's 61.3% annual growth in private debt is not all that out of line with other similar countries, but it must end:

Private debt in Romania increased an annual 61.3 percent in May, the Banca Nationala a Romaniei said on June 24....Borrowing in foreign currencies, mainly euros, rose 83 percent in the period while debt in lei increased 45 percent, the bank said.

Private debt accounts for about 40 percent of gross domestic product, similar to the level in Poland, Isarescu said.

Needless to say, one wonders how much of that 83% of Euro-denominated debt is stable!

``The economy has hit the wall,'' said Ken Wattret, senior economist at BNP Paribas SA in London. ECB officials ``run the risk of tipping the euro area into a recession'' as the inflation outlook increases the risk that the central bank ``may need to go beyond one rate rise.''...The Bloomberg retail index, based on a survey of more than 1,000 executives compiled by Markit Economics, fell to 44 this month from 53.1 in May. A reading below 50 indicates contraction. Europe's manufacturing and services industries also contracted this month.

Overall, virtually all of the major economic Q1 GDPs were revised lower. France was no exception:

France's gross domestic product rebounded less than initially estimated in the first quarter as household spending, the driving force of the economy, failed to grow....The first quarter ``was a bit supernatural,'' said Jean- Christophe Caffet, an economist at Natixis in Paris. ``From there on, growth figures will be particularly bad.''

What the spirit world has to do with GDP I do not know, but the very sharp drop in the retail index and stagnant French household incomes are going to also cause employment problems. So for the Eurozone as a whole we have declining retail PMI, declining manufacturing, and declining services. Barring massive increases in household debt a la Romania/Poland, nothing's going to keep this train moving down the tracks. The plummet in retail PMI down to the 44 range is probably just a signature of inflation. Carrefour had reported that spending on non-food items in its Walmartish stores dropped 8.8% in Q1. Retail spending in the big economies was very bad and appears to be continuing its drop:

Sales fell across Germany, France and Italy -- the largest economies in the euro zone -- led by Italy, where retail spending dropped at the fastest rate in the survey's history. A measure of employment in the euro region fell to 48.6 in June from 49.9 in May, the report showed, staying below 50 for a third month.

The impact on employment varies depending on how much of these individual economies is rooted into fundamental industry, and how much is based on construction/services, but employment in general is going to be constrained.

UK/Ireland: Ireland's economy had become too dependent on housing a la Spain. The UK is heavily impacted because of its reliance on services and financials. The outlook is bad and getting worse momentarily. UK services fell to a 12 year low, and Q1 GDP was revised down:

King said on May 14 that the country may experience the ``odd quarter or two'' of contraction. The bank predicted that the annual rate of economic expansion will drop to around 1 percent early next year, the lowest since 1992.

Consumer Spending

Household spending, which drove the fastest expansion in three years in 2007, is set to slow, King said. Higher fuel prices and the dearth of credit pushed consumer confidence to the lowest level since Margaret Thatcher was ousted from office in 1990, GfK NOP Ltd. said May 30.

It could be way more than the "odd quarter or two" of contraction. Household spending is worse than it appears judging by retail actions:

Tesco Plc, the U.K.'s biggest supermarket chain, and nearest rival Asda said they have cut prices further as grocery retailers battle for business from customers struggling with higher mortgage, energy and food bills.

Cheshunt, England-based Tesco reduced prices on 5,000 items this week and will cut 3,000 more from June 30, spokesman Trevor Datson said today in an e-mail. Asda, a unit of Wal-Mart Stores Inc., lowered the price of 10 top-selling products including bread and eggs for three days from today in a promotion it says will slash the cost of a basket of shopping by 54 percent....Recent figures have shown that the credit crisis has caused a sales boom at supermarkets such as Aldi and Lidl, with Aldi experiencing a 20 percent sales increase in the past four weeks, the London-based Times reported today.

What's happening is that the higher-end retailers are fighting to hold market share. Needless to say profits will drop in tandem, and employment is going to be a bit tight, wouldn't you say?

Now, against this backdrop, the chance for either the ECB or BofE to raise rates is minimal. They may do so one time as a shot against the onrushing current, but when you have banks struggling for money, constrained lending, and high private debt combined with rapid import price inflation you cannot control inflation by raising your rates. All you can do is control the expectation of inflation, which is a second order effect, and in exchange for that you run the chance of cliff-diving. With Brad & Bing, Barclay's and A&L in dicey straits, the UK is getting a retraction of easy money from the marketplace already.

Even though the US is suffering from a big housing bubble deflation, it is now in a more stable position than the UK, Ireland or Spain. Two graphs and posts from the most excellent UK Housing Bubble blog should demonstrate:The US housing bubble wasn't as large in relative terms:

As for Spain, well, US construction never got over 7% of GDP at the absolute highest, whereas Spain had moved into the 18% range.

The UK is now in the stage at which credit card spending is going up as people try to maintain living standards in the face of declining real incomes. This is the last gasp for the UK, and will end in a pretty strong downturn, because UK household debt cannot keep increasing at these levels. Please see the link for a piece of excellent analysis by Alice Cook. Bottom line, this is an inflation signature.

So what now? We have global correlations. I guess we all watch as oil rises every time stock markets drop on realistic expectations. It appears that oil speculation is the last refuge of idiots.

The entire world cannot support global growth based on nothing but spending increases in oil-exporting countries, so the game is over. The only question is whether we get a pretty strong global recession, or whether we get a global depression type event.

If the EU were to have its member countries cut fuel taxes sharply, it would help. At this point, any marginal gains in sanity are important steps to staying in global recession territory.

Yes, the UK is in a right pickle. Add to that the fact that their banks seem to be coming clean about writedowns of US debt at a ... ahem ... less impressive rate than others, and they seem completely pickled.

But why do you compare UK/Ireland/Spain figures to US figures? Why not team them up against California/Arizona/Florida?

Are you talking about household debt ratios or about % of GDP derived from construction?

We don't have great figures state by state, and it is the overall that matters, I think.

You'd be surprised at how many prosperous people there are in CA. Not all of them went for it. In fact, many of them sold out before the crash. People like Rob Dawg saw it coming, fobbed their real estate off and are sitting pretty.

I look forward to buying 3 for every one i sold in 2005-2006. I didn't want to sell, I was forced to sell by the bubble. Even though I didn't participate if I hadn't sold I would have gotten crushed in the collapse. Yes, MoM is correct about the millions in California who own outright (8 million) or have rational home mortgages (another 8?) For instance I pay for my golf course home mortgage plus taxes what a smallish 2br apt rents for around here. Maybe no hitting the lottery price appreciation when all is done but no ramen eating and a nice place to raise a family in the meantime.

The problem is we are geographically mixed all together. My immediate neighbor is burning $15,000/mo in carrying costs while three up the street pays a couple hundred insurance and $1000 per year in property taxes. Around the corner is the more typical late year property ladder failure. Paid in the $700s at the peak, remodeled and is asking $939k. Has tried auctions, FSBO and is now with a shady realtor. Future REO. It'll be strange.

The point is that while CA looks slightly more debt ridden it is two worlds, the low debt and the hyperindebted. Averages won't tell you much.

Rob - but the hyperindebted will fall by the wayside. According to Housing Tracker, there's a sharp spike in inventory in a bunch of places as Alt-A busts.

Bankruptcy, short sales or walkaways, a lot of individuals will be shedding that debt.

Don't take this wrong, because you were a rational investor, and that's why you sold out when you did. You never intended to participate in a bubble.

Nonetheless, when you look at the numbers, effectively you robbed a bank. The inflated values were created and funded by the loose lending standards. So your profits amount to a shift of capital out of irrational hands into rational hands, and you are not an isolated case.

I do think CA's economy will be bolstered by the bust after a few years, because a lot of this debt will evaporate, but the capital that moved into rational hands will stick. Also it will be easier for companies to expand.

Then, of course, there are all those renters who were trying to save to buy into the inflated market, but weren't willing to go for neg-am loans. Their attempt to save a 10% downpayment abruptly puts them into a very nice spot to buy. In many places, the 400K home is now at best a 300K home, and for condos, you can buy some at half off. That 30K 10% dp just turned into a 20% dp on a 150K condo.

No offense taken and while in a abstract sense I did rob some banks merely by selling at a price I knew to be unreasonable I do take a perverse pleasure in my last divestment. Sold to my listing agent who took at least a 20% hit in 26 months.

Yeah, CA will rise again. Maybe this time we might even try a representative democracy.